This 2016 Article IV Consultation highlights that growth in Tanzania has remained strong and inflation moderate during the past two years. Real GDP grew by 7 percent in 2015, with activity particularly buoyant in the construction, communication, finance, and transportation sectors. Inflation remained in single digits throughout 2015, averaging 5.6 percent, despite the significant exchange rate depreciation in the first half of 2015. Inflation in April 2016 was 5.1 percent, close to the authorities' target of 5 percent. The banking system appears sound overall, but there is wide variation within the system. The level of financial development has improved in recent years, though at a gradual pace.

The Debt Sustainability Analysis1 (DSA) indicates that Tanzania’s risk of debt distress is low. Under the baseline scenario, which assumes a scaling up of infrastructure investment, all external debt burden indicators are projected to remain below the policy-dependent thresholds. The public debt outlook also remains favorable. However, stress tests highlight vulnerabilities to exchange rate depreciation and lack of fiscal consolidation. These results highlight the need for Tanzania to continue implementing a prudent fiscal policy, with an overall deficit of about 3 percent of GDP remaining a good long-term fiscal anchor. An appropriate financing mix is also required. The increasing recourse to nonconcessional borrowing needs to be gradual and accompanied by strengthened debt management capacity and sustained reforms to public financial and investment management to preserve debt sustainability.

Background and Recent Developments

1. The accumulation of new external public debt has been gradual but steady since debt relief was provided under the Multilateral Debt Relief Initiative. Total public sector debt (external plus domestic public debt) gradually increased from about 20 percent of GDP in 2007/08 to an estimated 37.5 percent of GDP in 2015/16 (Text Figure 1). Most of the increase is due to public and publicly guaranteed (PPG) external debt.

Text Figure 1.Tanzania Public Debt, 2004/05-2015/16

Sources: Ministry of Finance and Planning, Bank of Tanzania, and IMF staff calculations.

2. While Tanzania’s PPG external debt is mostly concessional, borrowing on non-concessional terms has increased recently, partly due to the decline in aid from development partners. At end-2014/15, more than two-thirds of public external debt was owed to multilateral institutions, primarily the International Development Association (IDA) and the African Development Bank (AfDB). Government borrowing from commercial sources amounted to about 30 percent of the public external debt stock at end-2014/15, against about 2 percent at end-2009/10.

3. Domestic public debt totaled 8 percent of GDP at tend-June 2015. Domestic debt remains dominated by medium and long-term instruments, with Treasury bonds accounting for over 50 percent of total domestic debt and an average maturity of 7 years. Commercial banks continued to hold the largest share of government domestic debt.

4. The coverage of public debt in this DSA is restricted to central government obligations owing to data availability. Local government debt and public enterprise debt are not captured due to lack of reliable and timely data. However, since these entities are often unable to borrow externally without a guarantee from the central government, public debt data captures partially their debt exposure. To get a comprehensive picture of government domestic debt, several outstanding government liabilities and other contingent liabilities2 currently not accounted for in the debt stock are added to the first year of projection (2015/16). These are estimated at 7.6 percent of GDP and mainly include arrears to pension funds and loans to government entities, budget expenditure arrears, TANESCO’s arrears to its suppliers, and other actual or contingent liabilities.

Underlying Assumptions

5. To address the country’s infrastructure gap, the authorities have formulated a new Five-Year Development Plan (FYDP II) with large investment in a number of areas, including hydropower plants, roads, a standard gauge railway, the Dar es Salaam Port, and the water and transportation systems. While a significant share of this investment would be on budget, the authorities also intend to resort to public-private partnerships (PPPs) to limit government borrowing and risks to debt sustainability.

6. The current DSA3 assumes an increase in the fiscal deficit over the medium-term on account of public investment scaling up followed by gradual fiscal consolidation to maintain debt sustainability. The baseline scenario assumes implementation of the authorities’ economic and development agenda. In the absence of a detailed quantitative macroeconomic framework for the FYDP II at the time of discussions, staff explored the sustainability of a plausible medium-term investment scaling up scenario. Accordingly, the deficit is projected to increase to 4.6 percent of GDP in 2016/17 and remain at about 4.5 percent of GDP over the medium-term, before returning to slightly below 3 percent of GDP by 2022/23 consistent with regional commitments to converge toward the East African Monetary Union (EAMU) protocol. Domestic revenues are projected to increase in 2016/17 on account of expected gains from tax administration and policy measures and nontax revenue owing to higher contributions of parastatals to the budget (including a large one-off transfer on account of retained earnings) and higher efficiency in the collection of various fees. The revenue ratio is projected to further increase gradually over the medium-term, reflecting additional revenue mobilization efforts. Public investment would almost double in percent of GDP to about 9½ percent of GDP in 2016/17 and would remain high for a few years.

7. The other main macroeconomic assumptions are:

Growth is projected to remain strong in the next few years (about 7 percent), reflecting the scaling up of public investment, mainly in transportation and energy infrastructure. Over the medium term, growth is assumed to revert to its 15-year average of about 6.5 percent; the agriculture sector will remain important, and continued economic transformation through industrialization, human development, and an improved business climate is expected to support economic growth in the long-run.

Inflation is projected at about 5 percent consistent with the authorities’ inflation target and assuming a tight monetary stance over the medium-term.

The current account deficit is expected to widen to 9.1 percent of GDP in 2016/17 and remain high at an average of 8½ percent of GDP over the medium-term, reflecting high development and infrastructure needs which will continue to lead to large investment-related imports and current account deficits.

Aid and FDI flows. External grants and concessional loans are assumed to gradually decrease as a share of GDP consistent with the declining aid trends from development partners. FDI is assumed to partly finance some of the envisaged investment scaling up. Therefore, FDI inflows are expected to remain high at over 4 percent of GDP over the medium-term and then to stabilize at about 4 percent of GDP in the long-term.

External nonconcessional borrowing. In line with its medium-term debt management strategy and ongoing discussions with creditors, Tanzania would rely more than assumed in the previous DSA on borrowing from the regular windows of the World Bank and African Development Bank (whose terms remain much more favorable than available on international markets) and on domestic borrowing.4 More than 50 percent of the external financing in the long term would come from nonconcessional sources (see Text Figure 2).

Domestic borrowing. Net domestic borrowing would be maintained at moderate levels (about 1 percent of GDP) throughout the projection period. Real interest rate on new domestic debt would be lower than current levels, but would remain relatively high while the average maturity on domestic debt is assumed to be about seven years.

Selected Macroeconomic Indicators, Current vs. Previous DSA

2014/15

2015/16

2016/17

2017/18

2018/19

Long term (average 2020–35)

Real GDP growth (percent)

Current DSA

7.0

7.1

7.2

7.0

6.8

6.5

Previous DSA

7.2

7.2

7.1

7.0

6.9

6.6

Inflation (average)

Current DSA

5.4

6.4

5.4

5.0

5.0

5.0

Previous DSA

5.2

5.0

5.0

5.0

5.0

5.0

Fiscal balance (% of GDP)

Current DSA

−3.1

−3.3

−4.6

−4.5

−4.5

−2.2

Previous DSA

−4.0

−4.2

−3.0

−3.0

−2.9

−2.4

Current account (% of GDP)

Current DSA

−8.6

−8.6

−9.1

−8.8

−8.6

−8.0

Previous DSA

−9.5

−8.2

−7.0

−7.2

−6.9

−8.2

FDI (% of GDP)

Current DSA

4.1

4.5

4.2

4.2

4.2

4.0

Previous DSA

4.1

4.0

4.0

4.0

4.0

4.0

Text Figure 2.Foreign Financing Assumptions

Sources: Ministry of Finance and Planning, Bank of Tanzania and IMF staff calculations.

External DSA

8. All external debt burden indicators remain below indicative thresholds in the baseline scenario; however, under the most extreme stress test the external debt service-to-revenue ratio slightly breaches its threshold. The three debt stock indicators (relative to GDP, exports and revenue) all increase slightly in the medium-term before declining below initial levels by the end of the projection period, and remain well below their policy-dependent thresholds under the baseline and all shock scenarios. The debt service-to-revenue ratio, however, increases over the medium-term and remains slightly above initial levels at the end of the projection period. Under the most extreme stress test, external debt service as a ratio to revenue slightly breaches its threshold in 2020–23 in the event of a one-time 30 percent depreciation in the nominal exchange rate. In such a borderline case the probability approach is applied to assess the risk of debt distress.5 The results show that under this approach, Tanzania’s risk of debt distress remains low for all external debt indicators.

Public DSA

10. Public debt and debt service ratios also suggest a low level of vulnerability. In the baseline scenario, the PV of total public debt as a share of GDP is expected to increase modestly in the next few years (to a peak of 34 percent of GDP in 2019) and then to decline gradually over time. It would therefore remain well below the DSF benchmark level of 56 percent of GDP associated with heightened public debt vulnerabilities for medium performers, and the EAMU convergence criterion of 50 percent.

11. Stress tests confirm the importance of continued prudent fiscal policy. Under the historical scenario, the PV of public debt would keep gradually growing and breach the EAMU convergence criterion of 50 percent of PV of debt-to-GDP ratio in 2033/34. The debt service to revenue ratio would also reach much higher levels. The most extreme shock corresponds to a 10 percent of GDP increase in debt-creating flows in 2016. It highlights the sensitivity of debt dynamics to contingent liabilities, a useful reminder in a context where the authorities plan to utilize PPPs for large infrastructure projects. The simulations also suggest that an overall deficit of about 3 percent of GDP remains an appropriate long-term fiscal anchor for Tanzania to safeguard the low risk of debt distress.

Conclusion

12. Tanzania’s risk of external debt distress remains low with a baseline scenario assuming a prudent scaling up of public investment and temporarily higher fiscal deficits than in the previous DSA. However, creating fiscal space for higher infrastructure investment will necessitate sustained efforts to raise additional domestic revenue and streamline current expenditure, to avoid excessive recourse to debt. Reforms to increase spending efficiency, particularly in the area of public investment and enhancing debt management capacity, will also be needed. More broadly, the targeted high growth and structural transformation of the Tanzanian economy will require sustained efforts to tackle structural reforms.

13. Authorities’ views. The authorities agreed with the main results of the DSA, while stressing the need to find the right balance between continued fiscal prudence and addressing Tanzania’s large development needs guided by the FYDP II. The authorities’ own DSA (conducted in 2015) points to the importance of improving domestic revenue collection and strengthening debt management capacity to address new risks emanating from increased rollover of maturing domestic debt, and financing public investment through external nonconcessional borrowing.

1/ The most extreme stress test is the test that yields the highest ratio on or before 2026. In figure b. it corresponds to a One-time depreciation shock; in c. to a Terms shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock

1/ The most extreme stress test is the test that yields the highest ratio on or before 2026. In figure b. it corresponds to a One-time depreciation shock; in c. to a Terms shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock

2/Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

3/Export values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

4/Includes official and private transfers and FDI.

5/Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

6/Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

2/Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

3/Export values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

4/Includes official and private transfers and FDI.

5/Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

6/Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

This full Debt Sustainability Analysis replaces the previous update prepared in June 2015 in the context of the second PSI Review (IMF Country Report No. 15/181). The updated three-year average Country Policy and Institutional Assessment (CPIA) rating for 2012–2014 is 3.76 and now breaches the 3.75 boundary for a strong policy performer. However, narrow breaches less than 0.05 require two consecutive years of breach to qualify for an upgrade in the policy performance category. Therefore, as in the June 2015 assessment this DSA uses the policy-dependent thresholds for medium policy performers.

The baseline macroeconomic framework underlying the current DSA does not yet factor in the potential impact of possible future natural gas production from emerging offshore projects. Deep water exploration by major petroleum companies has confirmed large natural gas deposits but final investment decisions to construct natural gas terminals are still pending. Thereafter, the development phase would start, and it would take several additional years before commercial production and exports of LNG could begin.

The probability approach is applied to a borderline case, which is defined as one where the largest breach or near breach falls within a 10-percent band around the threshold. It incorporates a country’s individual CPIA score and average GDP growth rate, whereas the traditional approach uses one of the three discrete CPIA values (3.25 for weak performers, 3.50 for medium performers, and 3.75 for strong performers), and an average growth rate across LICs (for details see the Staff Guidance Note on the Application of the Joint Bank-Fund Debt Sustainability Framework for Low-Income Countries (SM/13/292).